Conglomerates enjoy resurgence in a slimmed down, Scandinavian disguise
Storskogen's success shows that there is demand for the old-fashioned conglomerate — just don't call it that
Swedish investment firm Storskogen made a strong debut on the stock markets on Wednesday with a 30% pop on the first day of trading. By market close on Thursday it was still 19% above initial public offering price.
In some respects, this is not surprising. It is a company with solid earnings. A banker on the IPO praised it as “well liked” and “deserving to be on the stock market”, while an investor called it “exactly the kind of thing we want to partner with”.
But what kind of thing is that?
Storskogen owns controlling stakes in many small to mid-sized companies which remain independent in their daily business. 50 years ago, it might have been called a conglomerate, but that label has gone out of fashion since the business model's heyday in the 1960s.
“It is a conglomerate-like business model,” confessed Lena Glader, CFO of Storskogen. “We acquire profitable small and medium-sized enterprises, with a proven track record and strong market position and we hold them with no exit horizon. We acquire a majority share or close to 100% of the companies.”
There are several companies that are run along similar lines in the Nordic region, but Glader prefers to speak of a "compounding model" rather than a conglomerate.
This linguistic tweak is part of a shift in emphasis towards the compounding of value through the reinvestment of earnings, which supports stock performance.
Although the terminology has changed, the market conditions that have produced today's "compounders" in the Nordic region are similar to those of the 1960s, which allowed the rise of the conglomerates in the US. Now as then, low interest rates mean cheap money for corporations to borrow for new acquisitions.
However, as many commentators are pointing out, the easy conditions of the 1960 were followed by the stagflation of the 1970s and subsequently higher interest rates.
This was one of the reasons for the demise of the conglomerates, but not the only one. The companies they bought did not always become more efficient and profitable, and the listed parent company often seemed to be valued lower than the sum of its parts.
The growing specialisation of analysts and portfolio managers made it difficult for institutional investors to value a collection of companies operating in different industries. Meanwhile, institutions were taking over from retail investors as the main owners of corporate America.
Berkshire Hathaway, one of the most successful remaining conglomerates, tends to be covered by insurance and financial specialists such as Morgan Stanley's Brian Phillips and UBS's Brian Meredith. But the company's holdings include not just insurers but also utilities, aerospace firms, construction materials suppliers, fast food chains and more, presenting a challenge for any research team.
This tends to result in lower multiples and opportunities for those investors that are prepared roll their sleeves up.
“M&A compounders are definitely still very attractive,” said a head of EMEA equity capital markets at a bank who observes the Nordics from London. “There has obviously been quite a compression in those multiples.”
The latest generation of Stockholm-listed compounders have performed well. They include Lifco, which owns small businesses in areas ranging from dental materials to demolition tools and is trading near 150% above its 2014 IPO price. Indotrade, which calls itself a technology and industrial business group, owns more than 200 companies across the world. Its stock is up more than 270% from the initial offering in 2005.
In an uncertain world, there is value in diversification, and investors in the Scandinavian compounders seem to have found a way to factor this in. But that does not mean that the market is open to any old collection of companies.
“Investors are looking for companies that can offer differentiated, solid, sustainable structural growth," said the banker. "As a business you can demonstrate that, but also show cohesiveness and strategies. If you do have as much diversity as Storskogen has then yeah, that will work. But the bar is pretty high for a new conglomerate story.”